The Volcker Failure

MacroAndCheese's picture


We all want sound banks.  We all want banks that are small enough to fail.  We all want the assurance that our deposits are safe, without having to bankrupt the FDIC in the event of a bank default.  The Volcker Rule accomplishes none of that.  While doing nothing to protect our money, the Rule will raise our cost of banking, and damage the liquidity and functioning of our capital markets.  At the same time, the Rule creates a false sense of security by purporting to take the steps necessary to protect us.

First, some disclosure:  I am a banker, or should I say, I am an employee of a European bank.  I manage money, and am not directly affected by the Volcker Rule.  But I'm in a good position to understand what's going on, because I have spent most of the past 23 years on bank trading desks.  The years that I was not on those desks were spent structuring investments similar in form to the ones that blew up and damaged us so badly.  (I can honestly say that the ones I contributed to were fine, were not mortgage-related, and matured prior to the crisis.)

To understand why the Volcker Rule fails so miserably, you have to understand a little bit about modern banking and capital markets, and the businesses that are affected by the Rule.  (Volcker himself has confessed to not understanding capital markets, and we can all take him at his word on that.)

There are three groups of bankers affected by the Volcker Rule: prop traders, market makers, and CDO structurers.

For almost all banks, their proprietary (prop) trading businesses are very small.  Prop trading has been out of favor for all intents and purposes since the large hedge fund LTCM blew up and required a bailout 15 years ago.  As a question of style, some banks do continue to maintain small teams of prop traders, while many have gotten out of the business altogether.  Prop traders tend to sit off by themselves and take positions in generally liquid investments like stocks, bonds, currencies, and futures.  They almost never take positions in illiquid assets, or things they can't easily and quickly sell.

Market makers...make markets.  When a customer calls to buy or sell something, market makers are prepared to satisfy that customer need, whether or not they have the security, or whether or not they want to buy it.  By definition, these traders take risk, because when they buy something from a customer, the value of what they bought will fluctuate.  There is no way to make a market without being exposed to price movements, though generally market makers do not take large exposure for long periods.  They often hedge their positions, or liquidate what they bought as soon as they can.  Market makers strive to capture the "bid-ask spread" by buying from one customer and selling to another at a slightly higher price.

Far from the trading desks--and I mean far away, like on a different floor or in another building altogether--are the CDO structurers.  "CDO" stands for "collateralized debt obligations," and their production requires sophisticated structuring, intensive legal work, and a nimble, dedicated sales force in order to create and distribute them.  Structurers make special purpose vehicles that buy bonds, loans, or mortgages (CBO, CLO, CMO), then slice them up (senior and subordinated, etc) and sell them off.   

The stuff of the financial crisis came right off of the CDO desks.  The packagers created securities that the rating agencies blessed with a triple-A label, even though they were nothing of the sort.  The structurers, rating agencies, and investors all believed the high-tech models that measured risk, based on an apple pie assumption that real estate never goes down and homebuyers never default, whether or not they have jobs, proper ID, or a pulse.  And if they do default, the property will always be worth more than the mortgage anyway.

It is not true that banks stuffed these CDO products onto the unsuspecting, certainly not for the most part.  In fact the banks that created the products were believers, and big buyers for themselves, Goldman Sachs notwithstanding.  After all, it was AAA, right?  Billions and billions of dollars of structured deals stayed on the banks' books.  These securities were never purchased by prop desks or market makers.  Instead, they were held among the banks' loan portfolios, in quantities so large that it was the top layer of management that made the ultimate decision to buy. 

To make matters worse, distributing structured deals is not easy.  The issuing banks have to find buyers for all classes of securities, all at once.  They might find buyers for 80% of the deal, but without that last 20%, the deal can't happen.  No distribution fees, no sales bonuses, no register ringing, no praise from the boss' boss.  So what did the banks do?  They bought that last piece themselves.  Often that piece was the riskiest--after all, they couldn't find buyers for it.

You may find this hard to believe, but the Volcker Rule does nothing to inhibit or prevent the creation, distribution, or investment in CDOs, CLOs, CMOs, or C anything else.  Zip.  Nada.  I pored over the document, and wrote it all up right here.

There is nothing "proprietary" about CDOs or CLOs, any more than there is about loans or mortgages.  In fact CLOs are just "collateralized loan obligations," and Volcker couldn't very well come down on those.  After all, that's what banks do.  But that's where the risk is. Banks go belly up from credit exposure of one form or another, whether it's death by subprime mortgages, bad loan portfolios, or CMOs.

But how do you take credit risk away from banks?  You can't, any more than you can take the risk of an auto accident away from the driver of a car.  What you can do is manage the risk.  You can make sure the banks are not too big to fail, because sometimes banks fail.  Or, if you want to allow for a certain number of big banks for economies of scale and cross-market efficiencies, you can charge them an insurance premium based on how large they are.  The larger the bank, the more it pays.  If banks don't want to pay the premium, they can split in two.  Or four, or eight.  This is the solution favored by our Secretary of the Treasury, Tim Geithner.

It's hard not to conclude that Mr. Volcker and his band of lawmakers mistook proprietary trading and market-making with unavoidable bank credit risk.  This is a huge mistake, and it will cost you money at the same time that it hurts our markets and our economy.

The damage won't come from firing all the prop traders, though they did no harm and made banks money, some even during the financial crisis.  To maintain well-functioning capital markets it's nice to have these guys around, because when you want to sell your Australian dollars or Apple shares, someone has to be there to buy from you, even if it's on an exchange.  But the banks never did have a lot of prop traders around anyway.  That's the Volcker Rule, engaging a team of surgeons and anesthesiologists to remove a hangnail.

The real problem is, what will become of market making.  The traders will be regulated to death, having to keep track of literally 17 different regulatory parameters controlling everything from hedging each and every transaction at the time of execution right down to traders' compensation.  Market making will require a team of compliance officers and chief executives willing to assume personal liability for what traders do, 24-7, three hundred and sixty-five days a year.

It'll be amazing if banks stay in the market making game at all, but if they do, it'll raise their costs dramatically, and there's only one place the extra cost will come from:  you.  Market making itself will be a more costly exercise, with wider bid-ask spreads to make up for the added infrastructure.  This means a genuine dearth of liquidity, the hallmark of a well-functioning capital market.  You won't feel it so much, but your mutual funds, IRAs, and pension plans will all pay more to transact, and they'll pass that cost on to you.

Volcker downplays the importance of liquidity, saying in his recent letter to rebut some of the criticism that we should not assume "market making brings a public benefit."  But don't follow what he says, watch what he does:  What single class of investments is exempted from the Volcker Rule?  US treasury bonds, of course.  What in the world would happen to our government bond markets without sufficient liquidity to support them?  And that's to say nothing about the risk of speculating in long-term bonds of any persuasion.

The Volcker Rule is an utter failure.  It in no way protects us in the manner that it sets out to do.  In fact, it confounds and burdens our banking system during a time that should be spent rebuilding and safeguarding against another crisis.  The Volcker Rule is a red herring that misdiagnoses the problem and applies the entirely wrong medicine to a benign, healthy part of the body.

Paul Volcker is an American hero.  At a time of runaway inflation thirty years ago, he had the backbone to raise interest rates to the breaking point.  The economy stalled badly, but as a result inflation was broken for generations.  Volcker laid the foundation for a healthy economy and one of the longest-running bull markets in modern history.  He should have quit while he was ahead.

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boiltherich's picture

And...  I just read over at Reuters that Citi is arguing for an exemption to the prop trading rules to allow for foreign debt market speculation, and sure as shit they will get it.  Just the first of many small concessions that when added up will do what all other regulation has done, gut the law and leave everything as the banksters like it. 

Volcker rule should exclude all sovereign debt-Citigroup

MEXICO CITY, Feb. 25, 2012 (Reuters) — A planned U.S. ban on banks trading for their own profit could hamper monetary policy and the ability of financial firms to manage risk unless foreign government debt is exempted, a top Citigroup executive said on Saturday.

boiltherich's picture

Just a thought on the proposed loophole posted above re Citi saying they need foreign speculation exempted; how easy it would be for them to simply do all proprietary trading denominated in foreign currency and call it foreign risk management. 

But then just a few minutes ago while looking for something else I saw this at CNBS:

Key SEC Regulator Calls for 'Re-Proposal' of Volcker Rule

A key U.S. securities regulator on Friday called for a "re-proposal" of a controversial ban on banks' proprietary trading, saying he fears a rush to implement it could cause major harm to U.S. markets.

"If the proposed rule changes as much as I believe it needs to at this point, the responsible course for us to follow would appear to be a re-proposal," said Troy Paredes, a commissioner at the U.S. Securities and Exchange Commission.

Paredes, a Republican, was speaking about the so-called Volcker Rule  , a provision in the Dodd-Frank Wall Street overhaul law that would restrict proprietary trading by banks and also limit their investments in hedge funds  .

U.S. regulators were recently flooded with thousands of comment letters about the proposal, many of which were strongly opposed to the plan.


Wow, that story sets a new low even for CNBS as to content and facts. 

Better idea all, just repeal the repeal of Glass-Steagall, as a START in reform.  We are either the banksters bitches or they are ours, if the last 15 years have proved anything at all it is that there is no middle course in this, and ethics must be made law with violations subject to at least minimum prison sentences at hard labor. 

Crawdaddy's picture

Again with the Vockler is a hero bullshit? Really? Vockler is part of the insane team that loves the idea of taxing our balls off in order to keep the spice flowing.He is an old school austerity lovin central planning asshole. Fuck him and the Trojan horse he rode in on.

He was part of the cabal that led that asshole Nixon to abandon gold in 71. The revisionists love giving him credit for (partially) cleaning up the mess he had a hand in creating. in 1982 he was forced to do the right thing by injecting liquidity, in order to give Mexico cash to service their debt held by US banks. He deserves credit for that, granted, but just because he sucked less than the Bernank and Greenspan, doesn't mean we need a ticker tape parade for this bozo. End the Fed!

boiltherich's picture

I think a lot of the real issue is the admission by Volker that he does not really know how the markets function, and though he was out of power during the run up to the greatest real estate bubble in history the same lack of insight can be said of Loanspan, Hank Paulson, and Timmy G. who were in control of money and credit under the BushCo Administration. 

I was lucky to have a professor in my first year of college taking a degree in finance who stressed certain things that were to prove very valuable later, for one thing money is not created when you crank up the printing press, it is created when a borrow/lend transaction occurs.  In this Volker did know something about the markets because his solution to the hyperinflation of the late seventies and early eighties was to choke the life out of the economy with 20%+ interest rates.  That price of credit caused a sharp contraction which lowered inflation to nil, but also triggered high unemployment and general misery, and the response by the people was to elect Raygun on his promises to bypass the Fed and create tons of new money via massive "tax cuts" and deficit spending.  He did not sell it that way to the public but that was what he intended and did.

What happened when 12 years of Raygun and BushCo 1 ran up deficits and quadrupled the debt that we had when Carter left office without offsetting spending cuts which has come to be known laughingly in politically right circles as "smaller government" and "lower taxes" is that we pumped the economy full of trillions upon trillions of dollars with compounding multiplier effects for two decades, the Raygun, BushCo 1 & 2 administrations were the absolute ultimate in Keynesian economics.  Money creation was exponential, and yet kept to the top few percent of the population, as their boats were lifted to the moon and everybody else got trickled upon. 

Welcome to the shining city on the hill folks, the cream done risen, this is the right wing paradise we were promised and so many of you voted for.  Mr. Obama (if that is his real name) is not really helping matters much, but then he inherited a system so corrupted by greed and so badly damaged that there is no way to fix it at this point short of a total redistribution, I just hope he can hold things together a few more months and that Romney is elected so that the proof of my thesis is known to all, because no matter who wins this next election will preside over the death of the current system if it even lasts that long. 

crowdoc's picture

Right on, Boiler! It started with Raygun and the con has been going on ever since.  From what I've experienced over the past forty years of hard work and dearly bought investment the "conservatives" have always made things worse for the average wage-earner, not better.  Don't know if anyone  can re-direct this mess of false conciousness but I'm sure hoping saner heads will somehow gain the power to deal straight with this mess and return things to an even keel.  Crikey- wadda goddamn mess these ideologues have brought us all!  So much for "free markets" and all the other tripe they've shoveled us.  They've proven their whole nut to be a load of b.s. that causes way more harm than good, locally and globally.  Epic FAIL!!

JGambolputty's picture

Bravo.  4 Stars.  The only thing worse than a legislature passing laws to fight the last war is one doing it to fight a misapprehension of the last war, and that is what we have with the Volcker Rule (and most of Dodd Frank, in fact).  Prop trading did not cause 2008 or even contribute to it in any significant respect.  Lehman was brought down by bad commercial real estate investments.  They were a bond trading house that wandered into the world of CRE lending at the wrong time in the cycle, didn't understand what they were doing until it was too late,  and they lost it all as a result.  The activity that killed or nearly killed each of the main victims in 2008 involved long term credit positions, not short term prop trading.  When you start with a misdiagnosis of the ailment, there is little chance the prescription will do any good.  Not that Congress should be likened to any profession requiring high IQ's and years of demanding and focused professional training.

moneymutt's picture

We could have survived Lehmans going down, what they claimed we couldn't survive was the hedges against Lehmans failure not being paid, so we were told AIG had to be bailed out...they let Lehmans go bust, but not AIG. If we can't let derivatives market go bust, why do we let the derivatives market exist? We were fine without it decades ago, the only hedgers could be people who had real involvement on market, just as the only one that can take life insurance on you are family members, dependents. But rules and regs that make sense for regular people markets, these are for little people, for bankers, they get all the profit of risk, but none of the downside, we pay for that. We either must regulate them, or freaking have public banks like public utilities, or regulated cooperatives like credit unions. We did this for many decades with no harm to our economy. But the idea they can run wild but we have to cover their losses to keep our economy functioning is so corrupt.

JGambolputty's picture

Lehman went bust.  The world didn't end.  AIG could have as well, with the same result.  Ditto for GS, MS and ML.  The reason the latter names didn't fail in the end and why we had the bizarre spectacle in 2008 of a Republican administration throwing out the laissez faire rule book and bailing out everything in sight was that IT WAS AN ELECTION YEAR (that, and the fact that Hank Paulson was one of Wall Street's own).  Remember?  This had nothing to do with saving the world; it had everything to do with saving the election for the GOP, while helping out friends of Hank. 

adr's picture

Those who depend on the system for their livelihood will defend said system even in the face of overwhelming evidence that the system does more harm than good.

I won't ever say that I understand the nuances of prop trading and HFT algo generation for front running markets. From everything I have read it seems the only goal is to make extra money off the wishes of clients. What should be simple is a convoluted mess of regulations, traders, computers, commisions, and pride.

Someone wishes to buy a slip of paper that says they own a share of something at a quoted price. Without a million dollar supercomputer or high level connections you essentially will never get the price you thought. Maybe you put in a sell order for $15.27, the trading house waits a bit and finds a buyer, during that time the price goes up to $15.29. Do you get the extra $.02? Or does the broker keep it? If the price dropped during the processing time don't you get less? Like micro-transactions in every Zynga game, the goal is to slowly bleed you dry without it being apparent that was the goal from the start.

It seems the big banks and trading houses will stop at nothing to figure out, more to the point, come up with new scams to make money from nothing. The CDO is one of the most insidious inventions to ever come across the face of man.

When I took out a mortgage I made a contract to borrow a set sum and pay it back to the lender based on the terms of the contract. That contract was essentially thrown out the window when the bank decided to package my mortgage with thousands of others and sell it off for a short term gain. The entire purpose of the lender borrower system became a sick perversion to settle for quick cash and leave some other patsy holding the bag.

I don't care if the Volker rule hurts big banks or makes it more expensive to trade securities. I believe all this trading and financial engineering has done nothing to benefit society. The con of the 401k has made a lot of brokers rich, but hasn't really helped most people retire wealthy. It was never meant to. Just like SS it was a ponzi from the start.

We would all be better off if Bank of America went bankrupt and every depositor was forced to open an account at a local credit union. You know what is funny about a credit union, the depositors own it. What a novel concept. If you deposit the money which is loaned out, you get paid pretty well for doing so. The interest rates set by the government may be low, but the dividends make up for it. The credit unions work like the original intention of the stock market. Sadly the original capitalist ideals governing the market have all taken a backseat to financial fraud, sorry proprietary trading.

moneymutt's picture

I'll take this guys word on the cost of market making....but whenever I hear a business plead some reg or tax will increase consumer cost I'm thinking it's more likely it will decrease the businesses profits. Do they really care about the consumers, they really care about profits, that's their jobs, if they can screw consumer or taxpayer to make profit, they will. So I distrust their concern for the "consumer".

But the author confirms my thoughts that unregulated derivatives are the real issue that wil lead to insolvency of banks...and Volcker does not seem to address that. What good is a hedge if AIG 2008 is the one to pay you in event of loss?, that's no hedge, that's pure risk.

The derivative market dwarfs our housing market and our stock market, and like a Ron Paul nirvana, it is completely unregulated, but like a Ron Paul nightmare, we taxpayers will be forced at gun point to bail this market out when it crashes again...we will both be taxed and also have "our" money printed from thin air to make sure richie riches never lose a dime even they tho they chose to lay money on a casino table. When I make a bad investment, bad loan, bad gamble I lose my money...these TBTF banks never lose even when they make a bad loan, a bad bet...because it is okay for regular folks to be broken and impoverished from say, mis reading the hosuing market or putting our retirement savings in the wrong investment... but they tell us if the big banks break we will be broken and impoverished...well, hell, we're already broken, while our GDP and corporate proifts have recovered, regular working folks have not....and the big banks that should have been bankrupt, still rule, without rules.

What I don't get is how we had boring, well-regulated banking without computers, no less, in the 50s and 60s and we had a thriving economy, in spite of the high labor costs of accounting transactions, the profit skimming of the spreads in trading, the slow response times etc. but now regs could kill banking and make it horribly expensive? How can we doing anything as close to as onerous as banking was in the 60s, and no one talked of credit crunch or overly expensive money then.

MacroAndCheese's picture

Yes unregulated derivatives are probably a huge risk.  No one knows.  The stuff has run ahead of government, as proven by Volcker and his Rule.

Downtoolong's picture

I see the author’s argument and point of view. But, it seems to come down to a matter of defining what proprietary trading is. In my view, when a bank decides to hold the riskiest illiquid portion of a CDO on its own books, hoping the day will  come when they can sell it to some unsuspecting boob in the free market, that is proprietary trading too. When they do it for the sole purpose of being able to market and profit today from the less risky slices of the investment, and damn the consequences, and losses down the road, that’s some of the worst risk management and banking practice I can imagine; hardly worthy of a mega bonus let alone a paycheck. When they do it knowing that the consequences and losses down the road will be borne by others who had no involvement on either end of the original deal, that’s criminal.       

MacroAndCheese's picture

I think that's the tragedy of the financial meltdown:  At the end of the day, there was a huge wealth transfer, mostly from the public to the hands of interested parties, big and small.  Yes Goldman Sachs, for example, got bailed out of its exposure to AIG--inexcusable.  When you're a big boy investment banker and you enter into swaps or options contracts with someone else, you take a risk on them.  Period.  GS was in no danger of failing, and yet we made them whole.

But look at the other end of the spectrum:  Someone buys a house he can't afford, with no money down and not even a proper job.  He can't pay the mortgage, and now he's living rent-free until the bank gets around to the repo.  Is that any better than GS, writ small?

moneymutt's picture

For a person in the industry, your knowledge seems high but your analysis seems stunted by your peers. Think.

The squatter not paying his mortgage is simply making the smartest buisness decision he can given the situation he is in. He, like the people that lent him the money (at least according to you), didn't expect his house to lose 30 to 70 percent of its value. Even if he had put 20 percent down, he would still be underwater, facing same choices.

If you think of housing as the asset most backing the big banks, and think what is in those big banks' interest, subsequent bank actions and govt policy in response to housing crash will make more sense. Govt policy is always consistently for the advantage of the banks, some limited and lame attempts at consumer protections aside. It is the banks that are letting squatters stay in their house, the squatters are not getting bailed out by the govt, as GSacs and all the other big banks did. Why are the banks letting the squatters remain so long?

Servicers with no skin in the game, in contrast, move as fast into foreclosure as they can, even when it hurts the value of the underlying investement they are servicing. When the mortgage is a MBS and the servicer's contract to manage that loan pays out more in profit to foreclose than to make a reasonable rework of the loan (like say a decrease in interest or principle to lure the mortgagee away from default) the servier will act against the interest of the MBS investment owners and foreclosure as swiftly as they can. This leaves the MBS investor with pennies on the dollar compared to making a deal to avoid a strategic default....due to high costs of foreclosure by servicer, legal, depressed price of house labeled as foreclosure. Servicers, often big banks, have been routinely reported to entice homeowners into a trial period of lower interest rates, all the while, the servicer had started foreclosing on them the first time they made lower payment for the "trial" period suggested to them by the bank. Also servicers were in such a hurry to foreclose and so obsessed with increasing the short term profits on this, they hired obviously schlocky foreclosure mill law firms and fraudulent robosigning document companies to get the paperwork they needed as fast as possible. If some squatters have gotten extra time in their house because the servicers took time to staff up to do foreclosures or becuase their fraud made them have to stop and do things right, so be it. Its not like the homeowners cried to govt for bail out and its not like their presence in the house is harming anyone, at least they semi maintain the house and protect from damage and thus avoid harm to the neighborhood. they were/are simply defaulting like a business would when the market suddenly turns on them and they have loans on a factory that is longer makes a profit and is no longer worth the loan against it. That is far from a bailout, it is default.

So why are some people able to squat so long, other than the robosigning mess? When the banks actually own the loans, realizing the lost value of them, marking them to market via the foreclosure process would wipe out their reserves. While regional and smaller banks are highly exposed to CRE, big banks are largely exposed to residential real estate. You are in the business, you tell me,....for every $200k loan that becomes only worth $75k given the drop in the value of the house and the cost of foreclosing on it, for that $125k loss in assets/reserves, how much lending ability does the bank lose? $1 million? How much can this happen before they are insolvent? So banks that own the loans let people squat. Lately I've read this is becoming rampant in high end homes worth more than a million. Banks are not foreclosing, not kicking the squatter out. The empty houses would take lots of money to upkeep, the loss on paper would be large. So banks preserve their assets but lose their income stream. Well they have a solution to that, a backdoor bailout, the income stream is helped by the Fed. The Fed lends them unlimited,money at nearly zero percent interest and they can prop trade if they like (make no mistake some banks have made huge money doing this in the last couple of years, just read ZH). Or they can just do a risk free transaction and lend the money to us, by buying TBills, and collect interest, from us, on the money the FED printed for them. So they stay solvent and still maintain some cash flow. And there are many other back door bailouts going on beyondsthese examples, again just read ZH.

If you look at all the govt programs to help underwater homeowners, they are almost always a bad deal for the homeowner but always help the banks. So when ever I hear politicians talking about helping homeowners, but their major political contributors are Wall Street, I know this is just a guise..they would never to have the political space to do something that was good for regular folks but really screwed the banks. If you are significantly underwater, what good is an interest rate reduction, or a change from 30 year term to 40 years? Even a small principal reduction leaves you still with significant negative equity. The homeowner in an underwater mortgage would be finacially so much better off defaulting, free squatting or not. They would be off the hook for $10s or $100s of thousands of unbacked debt. Sure it would come with credit rating consequences and may be inability to ever buy a house again, but still they would be far better off. But anything that keeps the homeowner paying monthly payments is a huge boon for the big banks, they don't have realize the loss to their reserves and they keep an income stream. So they govt "help" for homeowners has been in the form of paying the banks a chunk of taxpayer money for each homeowner they screw by keeping them in their underwater mortgage. And make no mistake, for each underwater squatter, there are many more faithfully paying on their horribly underwater mortgage. Many of my coworkers and younger friends in their 30s are underwater becuase they bought at the wrong time, when most people buy a house, 5 to 10 years after they started working. They don't want to default, they have jobs, they can pay, so they do. The only ones I know that have defaulted are those who lost their jobs or their businesses. Of course strategic defaulting increases in regions where houses have lost more value (I'm in MN) when people are not just percent under but 50 to 70, the negative equity overwhelems. But do you seriously anyone of these homebuyers when they bought the noise were thinking, hey, if the house goes down in value, I will expect and beg the govt to bail me out, and I just stratgetically default. No, everyone told them, houses will never significantly go down in value, you should plow every penny you have into a mortgage payment.

So to equate a minority of homeowners walking away or squatting til kicked out to the equivalent of TARP, bailing out AIG so they could pay their big bank customers 100 percent on the dollar and all the other back door bailouts the govt has given the big banks is an extreme reach. Regular people were seeing the price of housing getting out of reach, their mortgage professionals told them they could qualify for a big loan, the banks happily lent them the money....but the working person was supposed to be the smartest one and know he was overreaching while the banks and mortgage industry and rst of fiancial imdustry was giving him the loan are blameless? I fail to see how people squatting in houses after the market unexpectedly turned visciously, and banks had fraudulently bypassed centuries of property law and documentation requirements, is somehow more morally and intellectually corrupt than big banks, taking huge risks, and lending to any warm body so they could fraudulently sell crap MBSs and taking bailouts larger then what we spent on the entire Iraq war.

snowball777's picture

The worst insane gamblers are the ones that need OPM to get a seat.

boiltherich's picture

I want to say thanks to you also SJM; you have cleared up a point of contention at ZH that has roiled the board since 2008, that it was the "greedy" residential real estate buyers/borrowers that were the cause of the implosion.

You stated:  "The structurers, rating agencies, and investors all believed the high-tech models that measured risk, based on an apple pie assumption that real estate never goes down and homebuyers never default, whether or not they have jobs, proper ID, or a pulse.  And if they do default, the property will always be worth more than the mortgage anyway."

So many here have blamed our economic depression on buyers who paid too much, borrowed too much, and failed to honor their obligations to repay as the only systemic problem behind this, while others like me hold the average buyer blameless having been defrauded. 

If the bankers, ratings agencies, GSE's, investors, and government, not to mention George BushCo's "Ownership Society," and real estate agents pushing the base drug, I mean housing product on the ground level, if they ALL believed that housing could not go down and that none of, or an insignificant number of buyers defaulted, and the residual value of the residence was sufficient to sustain the model if they did default, well then what were actual buyers to think? 

I knew some who bought at the top of the market and they were panic buying because they saw prices appreciating at thousands of dollars per month, in some regions in excess of 10,000 per month.  Not only were they told that they were missing out on the ATM called a house, but that if they did not buy now they may never be able to afford a house.  If they had no down payment it was the bankers that said FINE!  If they had no stated income it was the bankers that said GREAT!  If they had no job and undetectable pulse the bankers said you are APPROVED!

Nobody feared they could not repay because they were PROMISED that housing never goes down, the implication being the Fed and government blew this bubble and they would support house prices at any cost.  If you found yourself in financial trouble unable to repay you could always sell at a tidy little (or big) profit.  They were told by those who KNOW better than they it was a risk free/reward rich venture.

And being average they might have known a lot about things like how to stuff one widget into the next socket, or they might be Joe The Plumber who knows a lot about shit clogged pipes but nothing about how the financial world works (and now wants to run for office).  I who do know something about how finance works (BS Finance 1996 and corporate trust department of a major regional bank as a trust administrator) I could see that A) the boom was totally unsustainable in that median incomes did not support the median house price by a lot and B) the 2005-2006 buying frenzy was an unsustainable bubble that was about to end badly. 

Alas, even I who did have some knowledge in the matter got burned.  I waited till 2008 when a house I had previously looked at and said "no thank you too expensive," had dropped by half and was now below the cost of building materials to replace it.  I waited till the PITI was down to 28% of my take home income to buy, but I still was forced to conclude a year and a half later it was a losing proposition and a horrifying place to live, it dropped by half yet again of what I paid, it is now cheaper to buy my former house than new mobile home.  (Aprox. $68,000 for a three story townhouse). 

The bottom line in all this was that greed overcame bank underwriting standards with the full approval of the Fed and federal government.  It just does not get easier to diagnose.  I say that even if borrowers had not defaulted on their mortgages in unusual numbers the structure of the credit instruments would still have eventually imploded because of the massive leverage they created and which could only have succeeded in the event of excessive inflation over their lifetime.  And that would have burned the investors because the yield to retail investors would not have matched the inflation needed to make these scams work.   

moneymutt's picture

Agreed, if your mortgage broker, a full time finamcial professional, says you qualify and you can always sell if you can't swing payments, and someone lending you the money, another full time financial professional, says they are willing to lend you the money, you are a good risk, given the asset backing the loan, and the govt says you should want to own a house and Forbes, and all the other financial magazines tell you how great housing is as an investment...why should the average consumer, who is not a full time financial professional, who does things like roofing houses, teaching kids, cooking food, selling appliances the sole blame for overreaching?

Truth is like all manias and bubbles, everyone got caught up in it, financial sector/private businesses, govt/politicians, non-functionig regulators/police, and average consumers. No one is blameless of stupidity and greed, but to put special or sole blame on the average working bloke is really tweaked.

But I don't believe, as this author implies, that most TBTF bankers didn't know they were selling compete crap in their MBS. Yes, many of their regular employees, and many employees of regular boring banks likely didn't know the fraud that was occurring, and we're caught up in the hype like the rest of society, but there are too many damning emails and sworn testimony to hide the fact that many more than just GSAcs knew they were packaging crap and selling it at a premimium by fraudulently misrepresenting the quality of loans. Why do you think they paid 25 year independent mortgage brokers $10,000s for each bad loan they produced? Bankers needed straw men that they could make look like a viable debt payer, so they could get rich off of selling more crap MBS.

Many bankers knew. Countrywide knew, why did Mozillo massively sell his stake before housing bubble burst, why did they create indymac?. Becuase they knew they were selling crap and violating bank rules, so they cheated and ran. Bank of America emails show they knew their MBSs we're crap. In fact we now know they went further and messed with the already lame loan info from lame brokers even more and further tweaked and lied about the quality of packages of loans before selling them to investment suckers who assumed the banks would not commit fraud. Citi, JP they all did it, committed fraud.

Just because many banks and many bank employees behave ethically, reasonable, and in compliance with the law, does not mean everyone does. Given the FBI was begging to be given resources to fight massive mortgage fraud they were seeing in 2003/4, but they were rebuffed, how was this not a single to bad actors, and big risk takers, to have at it. The fact no banker has been criminally charged for their fraud (we are only seeing investigations from civil suits), cofirms the fraudulent bankers were smart, morally corrupt, but smart to make these illegal profits.... worst that happens to them is some of the money is taken back...

snowball777's picture

But YOU signed the doc that said VAR at Prime + We'll Tell You Later and YOU took out the equity line and YOU have been living rent-free for a year.

Teeny violins. Can't hardly hear em.

boiltherich's picture

WTF?  The post above is proof that people do not read full posts but only to the point where their personal prejudices are triggered.  Well, good for you Snowball, the same violins play the same tune for you who if you own a house have lost so much in equity, and if you do not own have paid for the ongoing bailouts with your tax dollars.  But, you better hope to shit you die of a stroke fast and clean because if you EVER need help from any person for any reason karma will treat you to what you dish out.

Defaulters who have no choice, even strategic defaulters, you want to impose an artificial and ridiculous "moral" clause into their mortgage contracts, when the fact is that it is a business deal gone bad and nothing more than that.  No individual was responsible for this mess, and the house buyer was one player in 100 million.  But, I have to say the blame the holier than thou types like you heap upon the average house dweller is so wrong and over the top that it actually assuages the guilt of having had to walk away from a mortgage, in fact it makes me feel like smiling and flipping the bird to the entire right wing of the country and even consider chapter 7 on my remaining debts which I stayed current on after mailing back the keys to the house.  You gave me the name, now I may just play the game, car, credit cards, stuff it, and by the way, I lived in my house 2 months after giving up on the deceitful Chase bank, as soon as I determined the bank was not negotiating in good faith I started looking for an apartment.  That was Feb 2010, and to think, I could have lived rent free for the last 24 months and saved nearly $20,000 in rents, and since you think I am a deadbeat anyway I now wish I had. 

Silly negative Snowball with misplaced anger issues.  What's next?  Going to bitch about people who need to eat or wear clothes?  Maybe we can get our K Street owners to pass some laws saying that human value is exactly equal to the average daily balance in your checking and savings accounts?  And that human dignity is for those that can afford to pay for it. 

Widowmaker's picture

Without BANKER failure there would be no Volker anything.

The first three sentences tell every reader everything they need to know -- this author is playcating all that has happened in fraud banking and an attempt to marginalize decades of bullshit behavior and fraud.

Just like krasting, unaccountable book talking, acting like there isnt a market for failure and financial racketeering and trying to distract from incorporated fraud, worldwide.

If bankers gave even the slightest rip about "sound money" the INDUSTRY wouldnt be fraud and bullshit like it is, thus exposing this commentary as garbage and self preservation.

To the author: shut up and show us. End TBTF, crony bank holding companies, predatory finance, bailouts, and prove the system has even a shread of integrity that doesnt come at the expense of the public -- all of which are the heart of the banking complex.

Scapegoating laws and legislation doesnt remove bad BANKERS, nor has the industry, either. Quite the contrary.

Get a clue, reform starts from within where the industry of parasites has done absolutely nothing but fuck everyone over. Acting like that isnt the business model might help you sleep at night, but wont save whats left of your wretched soul.

Nice try though, even though i see right through you.

falak pema's picture

Banking world needs two major adjustments in order to prevent an outcome that is societal, way beyond its own destiny :

1°   Less power more humility and realisation they are now for DECADES to become just a UTILITY seller. Curtail all derivative plays which are naked. Make off shore banking transparent. 

2°  Admission that tHe assumption inherent in the Black- Scholes iconic formula, which allows banking world to postulate, in auto-nourishing closed loop, they have invented a permanent, new market, IS FALLACIOUS. It has created the myth of an unlimited horizon for capitalism in near-infallible, deterministic mode; through financial derivative type products; all shuffled around in special vehicles. This is MIRAGE and malign cancer to real economy. We have to put real economy center piece and make this convoluted, self feeding, bubble economy what it should be : a marginal play. A tail event in economic spread.

By allowing over twenty years of supply side impetus the TBTF entities become the de-facto economic MARKET itself, in deregulated Reaganomics ideology mode based on self serving banking circulatory logic,  we have destroyed the capitalistic construct. We have to get this market back by cleaning out first the AUgean stables of the banking world. OUT IN THE OPEN, NOT BEHIND CLOSED DOORS.

Whether the Volcker rule contributes to this or not is minor issue; its the political mind set that has to change, to impose all of the above on the financial sector in first world, and by riccochet in EM.

In order to avoid financial armageddon. Which will lead us, as in 1930s, to true military armageddon.

Time is  running out fast. And its the first world capitalistic construct, two centuries of it, which has to be reshaped PRONTO or die. AS the emerging trends of human plight as now so awesome that we will have to find new solutions which are not just "business as usual", the current can kicking leading us to armageddon road once again. Its nexus now visible both in Eurzone, as in Middle East, source of black gold wealth, life line to the financial world as the true commodity collateral of Oligarchy capitalism. 

Pax Americana will be the biggest loser in the planetary reset if this adjustment does not occur. As it has most at stake. Its current momentum is not one that enthuses confidence in its ability to : 1° admit the problem 2° Turn around the momentum from current collision course which the world construct now is taking, financially, economically and thus politically. That is the inevitable collateral when you wear purple. 

williambanzai7's picture

I fail to understand how the Glass Steagall approach somehow became obsolete because that moron Sandy Weil said so.

It is not lack of creative brain power that prevents a practical GS solution.

The industry has managed to sabotage regulatory oversight beyond repair. The VR, as mutated, will just create more revolving door jobs.

Break up the TBTF banks.

economics1996's picture

"Paul Volcker is an American hero.  At a time of runaway inflation thirty years ago, he had the backbone to raise interest rates to the breaking point.  The economy stalled badly, but as a result inflation was broken for generations.  Volcker laid the foundation for a healthy economy and one of the longest-running bull markets in modern history.  He should have quit while he was ahead."

Bull shit.  Paul Volcker raised interest rates, attracted foreign capital, the dollar peaked, there SHOULD have been much needed deflation for the American consumer, but the mother fucker was running the printing presses nonstop enriching Wall Street and the Federal Reserve.  10.6% increase in the monetary base, check it out for yourself.[1][id]=AMBSL

He was a greedy assed banker who saw a way to make millions for his buddies and did it.  When the American consumer should have been benefitting from the rise in the value of the dollar this pos was ripping them off.

chender's picture

Volker Smolker .... this is just a weak argument that relies on a poorly desribed rule by an old guy.  If we stand back and look at what we actually need the 'bankers' and I use that term loosely could help themselvesif we all considered what is at stake. (disclosure - I am an actual banker that worked in bank branches :-/  )

The issue at stake is FDIC and deposit insurance.  Simply put, we need a rule that forbids use of bank money covered by FDIC for any kind of risky trading stuff.  

For funds in the bank balance sheet beyond FDIC, knock yourselves out.  

Whats wrong with that?  (ducking for cover now)

i-dog's picture

I totally agree ... and, further, I question the need for a "federal" deposit insurance "corporation". There is no reason why banks and/or depositors can't carry their own insurance.

If banks were required by their depositors to demonstrate adequate insurance by a profit-making insurer, then the insurer would properly do the job of the [serially failing] "regulators" and rating agencies and perform its own due diligence on banks it was insuring. Depositors could also take out their own insurance on deposits held with insured or uninsured banks (guess which would be cheaper?!). In this way, it would be user-pays instead of a blank check from other more prudent taxpayers.

Jim in MN's picture

The Presbyterian Church USA had its 'safe' bond fund stuffed to the gills with mortgage-backed securities and related toxic waste by Wachovia subsidiary Evergreen Capital.  It lost a substantial part of this major national denomination's assets.  This was the SAFE low-risk fund.

I am calling BS on the big picture underlying this article, and I mean that in a substantive not rhetorical way.  Prop trading and the Volcker rule may indeed be a red herring, but the role of major banks and of financial engineering in bringing our system to its knees through both political corruption and rampant risk MISmanagement of Epic Fail proportions has to be at the core of any credible offering on financial matters.

Psychopaths never think they are psychopaths.  But you don't call them doctors and give them the scalpel.

MacroAndCheese's picture

You can call it whatever you want, you can call me whatever you want, but I will never blame others for my mistakes.  Do you think anyone on the planet legitimately trusts a salesman about anything?  If someone tells you real estate prices will go up forever does that sound reasonable to you?  Don't be a sap, and don't call me a psychopath just because you disagree with my view.

Widowmaker's picture

No one saw it coming, HONEST!

But hey, no one saw the record bonuses coming, either, so obviously that makes it okay.

Glad im NOT a fraud custodian in pinstripes.

Spigot's picture

Yes, the bonuses. After the "near failure of the financial universe" these ass hats gave themselves bonuses equal to 8% of one year. THAT, my friends, is what the story is. Not some fucking whine about some fucking Volker Rule. Back of hand to forehead whimpering by people who absolutely FUCKED OVER EVERYONE, and THEN publicly, without ANY shame, grabbed 8% of M1 for their "bravery in the face of battle"...

One of these day, son, your ilk will hang.

Bansters-in-my- feces's picture

Volker is part of the Criminal Terrorist Organization.

non_anon's picture

yep, a BSD helping his buddies out on Wall Street.

connda's picture

Boo hoo. Poor, picked upon banks.  Boo hoo!

Well, dry the tears Sunshine, it's time for large banks to find a new paradigm. 

engineertheeconomy's picture

Everyone should play MONOPOLY at least once in his life.

BUT, they should play by the real world rules.

1. The Banker has unlimited, unrestricted access to free money which he never ever has to pay back and he can spend it on anything he wants to at any time. He does not have to pass GO to do so. He can never be questioned and answers to no other player.

2. The Banker will keep an approximate tally of how much money he spends on himself and his friends, and that will be considered the "national debt", with the interest on said debt to be paid off by all the other players. Because of quantatative easing this amount to be paid to the Banker will of course increase every time you pass go. Again, the Banker can never be questioned. You just have to pay him how ever much money that he say's you do.   

3. Other players will start the game with no money except that which is loaned to them, with interest, pending good credit scores and loan approval. Since only the principle of the loan will be put into the game and never the interest, they will have to take out another loan to pay that interest. And they will have to take out another loan to pay that. And so on and so on.

4. Due to inflation, all players must pay 10% more for all goods and services every time they pass GO. And the boxes get smaller.

add more rules below

Reese Bobby's picture

  You are so full of crap.  Just for starters:

"In fact the banks that created the products were believers, and big buyers for themselves, Goldman Sachs notwithstanding.  After all, it was AAA, right?  Billions and billions of dollars of structured deals stayed on the banks' books."  “As long as the music is playing, you’ve got to get up and dance.” -Chuck Prince.  It's called a compensation scheme Sparky.


And I weep that your ability to front run clients on buy and sell orders may be hampered.


MacroAndCheese's picture

Sorry Reese, one of us is full of it and it ain't me.  I know insiders at one of the three largest banks in the US and I know perfectly well what they were doing and what they were thinking.

Your crowd is stepping in it.

Spigot's picture

M&C you are a true believer. How could it be any other way? How could you sleep at night if you did not believe?

All of the fucking big banks should have bit the big one during the crisis, been parted out and recycled. You dip shits are welfare queens. You did not take the hit. You are not a success. You all are failures. Big daddy Ben and Timmy had to fucking bail your asses out.

Yes, you believe. And you will believe as long as you are paid to believe. You will change your religion when you stop getting paid to be a believer. Go look in the mirror.

Reese Bobby's picture

Insiders!  Wow!  That really impresses a simple country boy like me.  I'll think about your great connections as I hunt squirrels and such.

A little advice for you numb-nuts:

"Check it out. Dustin Hoffman, 'Rain Man,' look retarded, act retarded, not retarded. Counted toothpicks, cheated cards. Autistic, sho'. Not retarded. You know Tom Hanks, 'Forrest Gump.' Slow, yes. Retarded, maybe. Braces on his legs. But he charmed the pants off Nixon and won a ping-pong competition. That ain't retarded. Peter Sellers, "Being There." Infantile, yes. Retarded, no. You went full retard, man. Never go full retard. You don't buy that? Ask Sean Penn, 2001, "I Am Sam." Remember? Went full retard, went home empty handed..."

buckethead's picture

I was tracking until your rebuttal included movie resets.


Banking at large always makes me wary. I appreciate M&C coming here to state a case.


Propaganda? How should I know. I really am a stupid redneck trying to make sense of shit way over my head. 


Opposing viewpoints helps me to do just that.

SAT 800's picture

I looked at his blog; I can't really get started on the true nature of speculation in markets here; (hint; you are not an investor and you never met an investor); but it does not include a performance record, or current portfolio; so it is completely usefless; just conversation. Much of which can be dispensed with by formal logic; it's simply nonsense.

MacroAndCheese's picture

How about an annualized return of over 20% since inception 4 years ago.  Since you have expressed an interest, I don't post performance info or other details because I don't want to get into entanglements with disclaimers, the SEC, etc.

I suppose your cynicism is healthy enough, and no one is twisting your arm to visit my site.

Spigot's picture

Kool! I have made 24% annualized return over the past 10 years as a buy/holder of gold bullion. I'm sure you are a skilled and knowledgable person. I have nothing on you in that realm. For all the machinations of your various complex trading strategies you are doing worse than those invested in gold bullion. Better get working on your fixed costs, too, as I'm sure that is eating your bottom line.

crowdoc's picture

Never mind the geniuses here, M&C, they all know more about your work than you do.  And how it will all fail real soon, too, as many have been predicting for several years now.

I for one appreciated what you had to say.

MacroAndCheese's picture

Thanks crowdoc.  The funny thing is, they're in attack mode, even though the Occupy crowd is the biggest opponent of the Rule, which I very clearly oppose.  I guess they think I'm secretly teaming up with Volcker so that when the Rule is overthrown, banks can at long last take over the world.

Or something.


bigwavedave's picture

We are all over-banked. Get a real job you parasite.

Spigot's picture

What? 15-18% of GDP is in "financial transactions and services" bin, right? Is that productivity or is that a malformation? The prior "healthy" economic portion of same would be 5% of GDP. I would say your characterization should be modified to "blood sucking parasite".

Tyler Durden's picture

Actually, here is a solution to all of prop trading's problems: since all banks were bailed out by taxpayers, they are implicitly all utilities. And as such, their amount of risktaking should be commensurate with the amount of sunk cost. Thus, every prop transaction should have a limited upside to 5% P&L cap (and as much downside as the bank deem necessary, knowing full well however that they will not be bailed out - after all nobody put a gun to the bank's head demanding it trade for its own account).

Ironically, as you likely know, many banks, especially European ones, had a hard limit of 5 point upside for all OTC/bond transactions even before Lehman. Not so the case with the major transgressors - we all know who they are. And since, as is claimed here, prop trading is a small portion of total activity (which is highly irrelevant as by its very nature which includes almost exclusive frontrunning of whale accounts), the balance sheet allocated to prop should also be limited to 5%. Of course, we dare you to tell Merill Lynch's shareholders whose prop positions, albeit in uber-illiquid products, is what blew up the company, that prop trading was a small fraction of all activity.

Oh, and by the way, the "market making" defense is nothing more than the "HFT provides liquidity" defense for prop trading - no they don't. All they provide is parasitical scalping, momo accentuation, and market efficiency destruction, while forcing flow aggregation in 1% of all stocks to create the impression that there is volume. Today's decade low volume has just shown that when you unmask the market's fake facade, it is hollow.

Prop traders will go away on their own once their implicit trading benefits - frontrunning flow, trading on inside information (the reason every Goldman prop trader would take out their best clients to strip clubs every night was not to debate the merits of the silicone vs saline), using expert networks (take a wild guess which clients accounted for 75% of expert network revenue - go ahead, guess), abusing market topology to commingle prop flow with electronic market maker (as a reminder, Goldman is still the #1 prop trader on the NYSE via Spear Leeds) and so forth - are gone. Oh yes, and the cozy excess volume, which has allowed them to mask their less than legal transactions in, is also now a thing of the past.

Volcker has nothing to do with it. But of course, the fact that prop trading is dying away for a whole different set of reasons is precisely why those defending it will shift the blame on the irrelevant scapegoat: it may work with the general public, but all those who know precisely what happens, will laugh at any such defense.

Incidentally, you are not the first to defend prop trading. Goldman beat you by over two years, when we made precisely the same observations as above, and before anyone had heard of the Volcker rule. They defended it then: now they agree with Volcker. Here is the link. Lucas van Praag is no longer with the firm, neither is 75% of Goldman prop trading. In fact, Goldman prop was the main reason for Goldman's abysmal 2011. Somehow we think their shareholders would have been delighted if prop had been banned when we made the case for precisely that. Because it is rather funny how such a "stable" and "innocuous" business can have such a huge impact on profit.

That said, we fell the pain of all prop traders: learning a new, and productive skill set is never easy.

Zero Govt's picture

if it was possible to give you 2 green arrows for that post TD i'd have given you 14

AmCockerSpaniel's picture

Glass-Steagall Act; Need I say more?

i-dog's picture

Yes. You do need to say more.

Glass-Steagall would have very little impact now ... just as it had very little impact during all the decades of rising deficits, closing of gold windows, and blowing of welfare, housing and dotcom bubbles. Its demise was simply another small nail in the coffin of the western ponzi.

Regulation is not the problem; the whole central planning system of free-spending governments handing out IOUs in the name of future generations is the problem.